The rupee inched up 0.1% against the US dollar on Wednesday and rose to its strongest in nine-and-a-half years.

Currency experts predict a further strengthening of the local currency as foreign exchange inflows surge into India attracted by a stock market, which is scaling record highs, and relatively high interest rates.

A day after the Reserve Bank of India (RBI) liberalized foreign exchange rules on Tuesday, there was much nervousness as the rupee opened at Rs39.64 against the dollar—weaker than its previous close of Rs39.73 against the dollar. Market experts said that there are fears that the rupee could even drop to the level of Rs38.50 against the dollar, if the central bank does not increase its level of intervention, by supporting the rupee.

On Wednesday, the rupee closed the day at ₹ 39.70 as the central bank was supporting the rupee at the level of ₹ 9.70-39.72 through the trading session.

Traders said public sector banks such as State Bank of India, Bank of Baroda and Bank of India were large buyers on behalf of RBI on Wednesday.

Ganesh Rao, chief executive of IBS Forex Ltd, a foreign exchange trading platform, said that the rupee remained “unaffected" on Wednesday by the measures announced by RBI on Tuesday. On the contrary, there was added nervousness as the union minister for finance P. Chidambaram expressed concern on the rising rupee on Wednesday.

Rao said the pressure would continue and there will be “no short-term effect of the liberalized forex rules," adding that the market is expecting the central bank to announce a half-percentage point rise in the cash reserve ratio or the minimum reserves that banks must maintain with RBI.

On Tuesday, the central bank announced a slew of measures for corporates, individuals and mutual funds that encourage dollar outflows.

Foreign exchange experts said the moves would have little effect since both companies and mutual funds are finding it difficult to invest abroad because of the subprime crisis in the US fuelled by underwriting loans to consumers with poor credit. In addition, the stock markets in India look far more attractive than the overseas bourses and there is little that the central bank can do to restrict foreign inflows. Foreign institutional inflows have been to the tune of $11.4 billion in the calendar year so far.

Pointing to the increasing interest rate differential between the US and India, Sundeep Bhandari, managing director and regional head of global markets, South Asia, Standard Chartered Bank (India) Ltd, predicted that inflow will only increase.

Investors in the US will borrow at a cheaper interest rate and invest in India, where the interest rates are high, he said, predicting that the rupee will end the year at Rs39.50 level against the dollar.